21 June 2012

More to it than oil prices #nlpoli

The problem for the provincial government is not whether they got the price of oil right in their budget. They’ve been underestimating for years. This year might be an over-estimate. In the short-term, they’ve still got lots of budget smoke and mirrors to cover off most of the likely outcomes. There’s no cause for panic, yet.

The problem for the provincial government is bigger than the current price of oil. Most of this will be familiar to regular readers, but at times like this it is worth pulling it all together in one spot so that people can see the big picture.

The Fragile Economy is driven by oil, minerals and provincial government spending. In 2008, for example, the value of all goods and services in the province was $33 billion. Of that, oil represented $12.7 billion and mineral shipments amounted to $4.7 billion. Government spending was around $7.5 billion.

Building your economy around a couple of commodities and government spending that comes largely from them is a Risky Business. Commodity prices go up and down. Right now we are in a boom. Experience teaches that prices will drop.

Dropping oil prices are what we are seeing right now, of course. One of the causes is - apparently - a drop in American demand due to a shift to using shale gas.

Dropping prices can lead to big problems when you don’t have too many sources of income. Kathy Dunderdale and her associates know this. She will even mention it once in a while. Oil prices are volatile.

Prices are one thing but the other half of it is how much oil we produce for how long. Oil production is declining. While there are new fields coming on stream, production from those fields – like the Hibernia extension – only make the decline less dramatic. Hebron may cause a bump back up when it starts up but even that field can’t replace the production from Hibernia, Terra Nova, and White Rose that’s already been pumped.

Hebron and Old People: Blame it on the Baby Boomers as they get old and retire. Blame on the historic tendency of provincial governments to overspend. Blame it on the current Tories who know their spending is unsustainable but who keep spending anyway. While government revenue from its major source – oil – will almost certainly decline over the next 30 years or so, demand for spending will just climb with the same sort of intensity.

Demand up.

Revenue down.

Still with it so far?

Then there’s that Massive Debt thing. The gross public debt – all the liabilities – stood at around $13 billion at last count, the same as it has been, give or take a billion, since 2003. Servicing that debt - just paying the interest costs - ate more than $837 million in 2010, according to the provincial Auditor General.

That’s a big drain of cash out of the government treasury every year. The provincial government has billions in cash but they refused to use any of it to make a dent in the debt load. If you don’t really see the value of paying down debt with oil money, take a look at this simple explanation from one analyst:

It is also perfectly in order to use the money to reduce debt. Suppose that a government is paying eight per cent a year on its debt. Servicing $1-billion worth of debt would cost $80-million a year, year after year. Pay off that $1-billion debt and the money that was going on interest is now reliably available to sustain new spending or reduce taxes, every year. Over 20 years you’d have an extra $1.6 billion to spend.

But wait a second, some of you are no doubt saying, Muskrat Falls is going to bring in new money for maybe hundreds of years. Yes, you’ve been listening to the Premier and her scrums.

Small problem: the same shale gas that is lowering the price of oil has already decimated the electricity markets in North America. Muskrat Falls electricity is simply too expensive to export.

And to make matters worse, the current provincial government plan for Muskrat Falls involves either spending some of those billions in surplus cash we mentioned a minute ago, borrowing and therefore increasing the already record provincial debt level, or doing some combination of both.

Surely, you might be thinking, the smart people in the provincial government and Nalcor know all this, so it just can’t be true. They wouldn’t make things worse.

Smart has nothing to do with it. Smart people make mistakes all the time. The 1969 Churchill Falls deal came from smart people. The provincial debt? Smart people. Smart people built spaceships that worked for 30 years carrying people to orbit to do all sorts of amazing things. And those same smart people built the shuttles that exploded right before everyone’s eyes.